Fresh sign that Fed is falling out of love with QE

Posted by Greg Robb, MarketWatch

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There is more evidence that the Federal Reserve is falling out of love with asset purchases.

Economists at the San Francisco Fed Bank released a paper on Monday estimating that asset purchases, also known as quantitative easing, add only “a moderate  boost” to economic growth.

And that boost itself is dicey, as it really depends on the central bank promising not to raise short-term interest rates, the study found.

The economic letter, written by Vasco Curdia and Andrea Ferrero, senior economists at the San Francisco regional bank, focused on the Fed’s second round of asset purchases: $600 billion of long-term Treasurys purchased between November 2010 and June 2011. The economists said the purchases added about 0.13 percentage point to real GDP growth.

And without the guidance from the Fed that  rates would be held close to zero, QE2 would only have added 0.04 percentage point to growth, the economists found.

There was no discussion of the cost of QE2 in the paper.

The Fed is currently buying $85 billion a month in Treasurys and mortgage related assets. It has signaled it wants to pull back the stimulus. Charles Evans, the president of the Chicago Fed, estimated that the central bank will buy $1.2 trillion of assets once the third round of the program is completed.

The study fits with the view of some monetary policy experts who argue that asset purchases are really just “earnest money,” or a signal to markets that the Fed is going to keep interest rates low for longer. In other words, while the Fed is buying assets, it won’t be raising rates.

According to this view, once the Fed starts to taper asset purchases, the market will quickly turn its attention to when the Fed will hike rates.

The study itself concludes:  ”Communication about when the Fed will begin to raise the federal funds rate from its near-zero level will be more important than signals about the precise timing of the end of QE3.”